Corporate Governance, Family Ownership and Earnings Management: Emerging Market Evidence

www.sciedu.ca/afr Accounting and Finance Research Vol. 2, No.
4; 2013
Published by Sciedu Press 17 ISSN 1927-5986 E-ISSN 1927-5994
Corporate Governance, Family Ownership and Earnings Management:
Emerging Market Evidence
Hmeyra Adgzel
1

1
Faculty of Economics and Administrative Sciences, Baheehir University, stanbul, Turkey
Correspondence: Hmeyra Adgzel, Faculty of Economics and Administrative Sciences, Baheehir University,
stanbul, Turkey.Tel: 90-212-381-5629. E-mail: humeyra.adiguzel@bahcesehir.edu.tr

Received: August 20, 2013 Accepted: September 9, 2013 Online Published: September 25, 2013
doi:10.5430/afr.v2n4p17 URL: http://dx.doi.org/10.5430/afr.v2n4p17

Abstract
Earnings management (EM) is particularly important for family-firms which are exposed to more severe type-II
agency conflicts between minority and majority shareholders than non-family firms. This study investigates the
effectiveness of independent boards, audit committees and the presence of an internal audit function (IAF) in
monitoring and controlling EM in family-owned firms. Overall, the results suggest that total accruals management is
lower in family-owned than in non-family-owned firms, but that there is no difference in the direction of accruals.
Family ownership is also found to reduce the monitoring effectiveness of independent boards and IAFs regarding
earnings management.
Keywords: Family-owned firms, Aggregate accruals, Type-II agency conflict, Board independence, Audit
committee independence, Internal audit function
1. Introduction
Recently, although some studies have argued that family ownership is associated with higher earnings quality and
firm performance (Ali, Chen, & Radhakrishnan, 2007; Anderson & Reeb, 2004; Wang, 2006), earnings management
(EM) has become an important issue for family-controlled companies. Family firms certainly have less serious
agency problems because of their reduced separation of ownership and management; however, they do have more
serious agency problems between the controlling family and the minority shareholders (type-II agency problem).
Corporate governance mechanisms have received substantial scholarly attention as a way to reduce EM. There are a
considerable number of studies (see for example Chang & Sun (2010), Chtourou, Bedard, & Courteau (2001), Jiang,
Lee, & Anandarajan (2008), Klein (2002), Larcker, Richardson, & Tuna (2007), Xie, Davidson, & DaDalt (2003) in
the U.S; Baxter& Cotter (2009), Davidson, Goodwin-Stewart, & Kent (2005) in Australia; Peasnell, Pope, & Young
(2005) in the UK.; Bradbury, Mak, & Tan (2006), Rusmin (2010), Saleh, Iskandar, & Rahmat (2007), Siregar &
Utama (2008) in the Asian Countries) which document that the effectiveness of corporate governance mechanisms
affect the EM practices of widely held public firms, however there are relatively less studies (Prencipe & Bar-Yosef,
2011; Jaggi, Leung, & Gul, 2009) which investigates whether the measures of corporate governance have the same
effect on the level of EM when ownership is not widely dispersed, and in particular when ownership is concentrated
in the hands of families.
This study contributes to the existing research by searching whether family ownership moderates the effectiveness of
corporate governance mechanisms in reducing EM practices on a sample of Turkish firms. This is the first study
investigating the EM made by family firms in Turkey. Turkey has an ideal setting to handle issues related to EM in
family firms due to the presence of the large number of family firms among its listed companies. When we also
consider the small and medium-sized enterprises owned by families besides the listed family firms, the total
contribution of family firms to national income in Turkey is higher than 90 percent (Ankara Chamber of Industry,
2005). In Turkey, considering ultimate ownership rather than direct ownership, approximately all the publicly-held
holding companies keep control over a large number of firms through a pyramidal structure. Families generally have
control of the holding company, and have shareholdings in many other companies. On the other hand, in most cases,
companies own shares hierarchically in each other under the holding company. (Demirag & Serter, 2003; Yurtolu,
2003). Mitton (2002) suggests that legal protection deficiency over property rights provides firms some power to
expropriate minority shareholder interests. In Turkey, there is inadequate protection of minority rights because of the
www.sciedu.ca/afr Accounting and Finance Research Vol. 2, No. 4; 2013
underdeveloped equity culture of capital markets, the dominance of long term debt finance, and the inadequate legal
environment.
La Porta, Lopez-de-Silanes, Shleifer, and Vishny (1998) argue that the primary conflict in a firm which is owned by
a relatively few shareholders is between majority and minority shareholders because of the potential of the former to
expropriate wealth from the latter. Especially in emerging markets such as Turkey (Note 1), where ownership is
mostly in the hands of families and hence market control mechanisms are weak, corporate governance has to go
beyond just solving agency problems between executives and shareholders. Rather it is important to solve conflict
between ultimate shareholders who take an active role in the company (generally families) and minority shareholders
and creditors.
This study first evaluates whether, in Turkey, Type-II agency problems between minority and majority shareholders
outweigh the persistent Type I agency problems in family firms between shareholders and managers. It is
conjectured that, if Type-II agency conflict dominates Type-I in family firms, income-decreasing EM will be higher
than income-increasing EM. Ali et al. (2007) provide evidence for that prediction for US firms, where discretionary
accruals are more negative for family firms than for non-family firms, which shows the dominance of
income-decreasing accruals.
Second, this study examines whether family ownership reduces the monitoring effectiveness of independent boards
in detecting and moderating EM in Turkish firms. It is conjectured that the existence of family ownership is likely to
reduce the monitoring effectiveness of an independent corporate board as owning families have control over the
appointment of board members and generally prefer to establish boards that do not try to alleviate their discretion
over decision-making (Anderson & Reeb, 2004; Chen & Jaggi, 2000). Prior research has also provided evidence for
that prediction (Prencipe & Bar-Yosef, 2011; Jaggi et al., 2009).
This study then examines whether family ownership reduces the controlling effectiveness of independent audit
committees on the level of EM. It is suggested that the existence of family ownership control in firms reduces the
monitoring effectiveness of independent audit committees. Prior studies have generally evidenced that audit
committee independence reduces the level of EM in publicly-listed widely held companies (Baxter & Cotter, 2009;
Chang & Sun, 2010; Xie et al., 2003). However, there is one study (Jaggi & Leung, 2007), to my knowledge, which
provides evidence that the family-controlled Hong Kong firms were less likely to have audit committees focusing on
EM when there are family members on corporate boards. This study thus extends the current literature by evaluating
the effect of family ownership control on the effectiveness, rather than merely the presence, of independent audit
committees in reducing the level of EM.
Finally this study evaluates whether family ownership reduces the monitoring effectiveness of a firms internal audit
function (IAF) on EM. Empirical research investigating the monitoring ability of an IAF on the opportunistic
behaviors of managers is limited not only for family firms but also for widely-held companies. One prior study used
archival data to investigate the effect of IAFs on EM, but found no evidence that the presence of an IAF is associated
with a lower level of EM in widely-held companies (Davidson et al., 2005). Expanding the scope of Davidson's
study, Prawitt, Smith, & Wood (2009) have found evidence that high IAF quality is associated with a moderation of
the level of EM. This study extends current literature by evaluating the effect of family ownership control on the
monitoring effectiveness of an IAF on the level of EM.
This study consists of the firms traded on the Istanbul Stock Exchange (ISE) for the period 2006-2010. Content
analyses of the yearly annual reports of all non-financial firms listed in the ISE for each reporting period between
2006 and 2010 were carried out to determine the internal corporate governance characteristics. Because of
non-availability of required corporate governance data final sample includes 410 firm-year observations.
Following the broad operational definition used in many of the previous studies (Barnes & Hershon, 1976; Carsrud,
1994; Gallo & Sveen, 1991), in this study, companies in which one or more families linked by kinship, close affinity,
or solid alliances hold a sufficiently large share of capital is assumed as family firms (Corbetta, 1995; Prencipe,
Markarian, & Pozza 2008) and hereafter stated as family-owned firms. In the study the magnitude of discretionary
accruals is used as a proxy for EM. Discretionary accruals are measured by using the performance adjusted
discretionary accruals model suggested by Kothari, Leone, and Wasley (2005).
The remainder of this article is organized as follows: The second part briefly describes the institutional environments
and ownership structures of Turkish firms. The literature overview defines the family firms and considers the
theoretical and empirical literature on corporate governance, agency costs and EM for family firms. Hypotheses are
then developed based on the findings in the literature, and the methodology and data collection described. Finally,
the results are presented and discussed, and conclusions drawn.
2. Institutional Environments and Ownership Structures of Turkish Firms
Corporate governance structure in Turkey can be classified as continental Europeantype, with long-term debt
finance, ownership by large block-holders, weak markets for corporate control, and rigid labor markets.
Publicly-held joint stock Turkish companies have highly concentrated and centralized ownership which is mainly
achieved via pyramidal or complex structures and by using dual-class shares (Yurtolu, 2003). Turkish law does not
have the one-share, one-vote principle, and Turkish companies can issue shares which has different cash-flow rights
and different collateral rights in liquidation. Under Article 401 of the old Turkish commercial law, (Note 2) it was
possible to issue non-voting shares and shares which had an arbitrarily high number of votes (Demirag & Serter, 2003).
In Turkey, considering ultimate ownership rather than direct ownership, approximately all the publicly-held holding
companies have control over a large number of firms through a pyramidal structure. Families ultimately own
sixty-eight of the top ninety-four Turkish traded companies with an average ownership stake of 52.05 percent of the
equity capital for the year end 1999 (Demirag & Serter, 2003). More recent evidence of families ultimate ownership
of Turkish companies is provided by Yurtolu (2003). Of a sample of 305 companies listed on the ISE at the end of
2001, she analyzed the pyramidal ownership structures and the impact of dual-class shares and found that families
controlled 242 of the 305 listed companies with an average 67 percent control rights of outstanding shares.
Pyramidal structures are preferred in Turkey to raise external equity while retaining control in short leverage. These
structures enable owners to keep ultimate majority control with controlling an unequal amount of cash flow rights
(Demirag & Serter, 2003).
3. Literature Overview
3.1 Definition of a Family Firm
Prior research provides evidence that family businesses are distinct from their non-family counterparts. Some studies
exhibit that the family firms perform better than non-family- firms (Anderson & Reeb, 2003; Beehr, Drexler, &
Faulkner, 1997; Daily & Dolinger, 1992; Lee, 2006) while some show the reverse (Gallo, Tapies, & Cappuyns, 2000;
Gomez-Mejia, Nunez-Nickel, & Gutierrez, 2001; Villalonga & Amit, 2004; Klein, Shapiro, & Young, 2005). To
understand the mixed results of studies about family businesses, it is important to clearly define what a family firm is.
The literature provides several different operational definitions of family firms which focus on some combinations of
components of families involvement in the business (Chrisman, Chua, & Sharma, 2005). Besides these operational
definitions, there are two dominant theoretical approaches to the definition of family firms (Siebels &
Knyphausen-Aufseb, 2011): the components-of-involvement approach and the essence approach (Chua, Chrisman,
& Sharma, 1999). According to the components-of-involvement approach, it is a sufficient condition that some kind
of family involvement exists, such as ownership, management, or governance to be considered as a family firm
(Chua et al. 1999; Chrisman et al 2005). The important problem associated with this approach is that in some cases
companies which have same level of family involvement in ownership and management may not consider
themselves family firms and may not behave as family businesses. Therefore, the essence approach requires that
family involvement must be directed toward behaviors that provide distinctiveness before a company can be
considered a family firm (Chrisman et al 2005).
3.2 Corporate Governance, Agency Costs, and EM in Family-owned Firms
Agency theory is a dominant theoretical framework in family firm governance studies, and it has been broadly
applied in the area of family business and corporate governance (Siebels & Knyphausen-Aufseb, 2011). Considering
family businesses, there are two opposite views about the level of agency costs. On the one hand, some researchers
theorize that family firms are exempt from the problem of agency because of their altruistic, intra-familial element
(Jensen & Meckling, 1976; Daily & Dollinger, 1992). The logic behind Jensen and Mecklings claim is that
management by the owner eliminates agency costs because most agency costs are caused by conflicts that arise from
the seperation of ownership and control (Type I agency conflict). On the other hand, family firms may be exposed to
more agency costs than their non-family counterparts because of 1) altruistic behavior, and 2) management
entrenchment and shareholder expropriation (Schulze, Lubatkin, Dino & Buchholz, 2001).
In parallel with the two opposite views of agency costs in family-controlled firms, there are also two opposing
theoretical viewpoints related with the impact of family ownership control on EM. In the first view, family control
reduces the level of EM. The US-based studies of Jiraporn and Dadalt (2007) and Wang (2006) and the Italy-based
study of Prencipe and Bar-Yosef (2011) all provide empirical evidence that the level of abnormal accruals is lower
for family firms than for their non-family counterparts. These findings suggest that the founding families long
tenure in the company causes them to focus more on the long term and limit the fears of management to meet
short-term earnings expectations. Additionally, their long tenure provides the firm-specific knowledge, enabling
them to better monitor management.
Although family ownership control moderates the agency conflict between managers and shareholders (Type I
agency conflict), it causes a conflict between controlling shareholders (generally families) and minority shareholders
(Type II agency conflict). The replacement of one type of agency problem with another has important meanings for
family firms. The positive impact of eliminating Type-1 agency conflict may be outweighed by the negative impact
caused by management entrenchment (Bhaumik & Gregoriou, 2010). There is a likelihood of EM for firms in which
ownership is mostly held by blockholders like families (Fan & Wong, 2002), and the peculiar governance
characteristics of family firms enable easy expropriation of non-family shareholders. One of the major governance
characteristics of family firms is the close relationship between family members and managers; in most family firms
managers are either members of the controlling family or linked to it by close personal relations. This close
relationship may direct managers to manage earnings toward the goals of the controlling family at the expense of the
wealth of minority shareholders.
4. Hypothesis Development: Corporate Governance and EM in Family-owned Firms
4.1 EM in Family-owned Firms
As discussed earlier, non-family-owned firms have more serious Type I agency problems than family-owned firms
due to the separation of ownership and management. There are many incentives for managers to manipulate earnings
opportunistically for their own welfare. Executive compensation schemes which tie managers incentives to
company performance may encourage managers to manipulate accounting numbers (Bergstresser & Philippon, 2006;
Cheng & Warfield, 2005; Guidry, Leon, & Rock, 1999; Healy, 1985; Holthausen, Larcker, & Sloan, 1995; Iatridis &
Kadorinis, 2009; Shuto, 2007). Additionally, managers may opportunistically manipulate earnings to meet particular
benchmarks, such as zero earnings (avoiding losses), prior period earnings (avoiding earnings decreases) and
analysts forecasts (Bartov, Givoly, & Hayn, 2000; Barua, Legoria & Moffitt, 2006; Burgstahler & Eames, 2006;
Choi & Lin, 2006; Kasznik, 1999; Kasznik & McNichols, 2002; Matsumoto, 2002; Matsunaga & Park, 2001).
Another incentive to manipulate earnings is debt covenants; managers are more likely to prefer accounting
procedures that shift reported earnings from future periods to the current period when the firm is closer to violation
of accounting-based debt covenants (Bartov, 1993; DeFond & Jiambalvo, 1994; Iatridis & Kadorinis, 2009; Sweeney,
1994). Finally, in firms about to go public, managers may also manage earnings to increase current earnings before
initial public offerings (IPO) and seasoned equity offerings (SEO) in the hope of receiving a higher price for their
shares (Aharoni, Wang, & Yuan, 2010; Cohen & Zarowin, 2010; Cormier & Martinez, 2006; Friedlan, 1994;
Jackson, Wilcox, & Strong, 2002; Shivakumar, 2000; Teoh, Welch, & Wong, 1998a; Teoh, Welch, & Wong, 1998b).
Most of these manipulations are achieved through income-increasing accruals that shift reported earnings from future
periods to the current period. Although factors such as legal liabilities and reputation concerns in the labor market
help reduce Type I agency problems, they do not totally eliminate them. On the other hand, family-owned firms are
exposed to more serious Type II agency problems because of families majority ownership patterns and significant
control over firm management. This causes managers to manipulate earnings through income-decreasing accruals to
meet the long-term expectations of family members rather than to achieve short-term goals. The desire to reduce
political costs or minimize tax may motivate family-owned firms to generate negative accruals(Ali et al., 2007). It
can thus be assumed that, on average, the managers of family-owned firms have both incentives to increase income
through income-increasing accruals because of a persistent Type I agency conflict as well as incentives to decrease
income through income decreasing accruals as a result of a Type II agency conflict. Prencipe et al. (2008) provide
empirical evidence that the incomplete elimination of Type I agency conflict in publicly-listed family companies,
showing that managers are still motivated to manage earnings for debt-covenant and leverage-related reasons.
It is conjectured that if Type II agency problems dominate Type I agency problems in a family-owned firm,
discretionary accruals will be more negative compared to those in non-family-owned firms, which will shows less
opportunistic behaviors by managers. The following hypothesis is developed to test this expectation:
Hypothesis 1: There is a significant difference between the direction of abnormal accruals of family-owned firms and
non-family-owned firms.

4.2 Elements of Internal Corporate Governance and Testable Hypothesis
The accounting policies which are a part of firms overall need to minimize its cost of capital and contracting costs
are largely determined by the firms organizational structure and are a part of the overall process of corporate
governance (Scott, 2006). The corporate governance model developed by the Institute of Internal Auditors (IIA)
specifies four cornerstones of effective corporate governance; the audit committee of the board of directors,
executive management, internal audit function, and the external auditor (IIA 2005).
4.2.1 The Board of Directors and EM in Family-owned Firms
The role of the board of directors in corporate governance is to monitor managers performance when conducting
business to the benefit of shareholders. It is expected that the more independent the board of directors is, the less
earnings manipulation will be possible for the managers (Chtourou et al., 2001; Davidson et al., 2005; Osma, &
Naguer, 2007; Peasnell et al., 2005). However, considering family businesses, there arise some specific and
characteristic agency issues, such as the owning familys pursuit of its own economic interests; its pursuit of its own
non-economic interests; the parental tendency to act upon altruistic motives; and the different nuclear family units
pursuit of their own interests (Bammens, Voordeckers, & Gils, 2011). These issues may present barriers to the
independent board's monitoring effectiveness in reducing EM practices. In most of the family-owned firms, the
families generally prefer to establish boards that do not try to alleviate their discretion over decision-making
(Anderson & Reeb 2004; Chen & Jaggi 2000). This may reduce the ability of boards to curtail the activities of
managers who are generally family members or have close relationships with the owning family, and who may try to
manage earnings toward the goals of the controlling family at the expense of minority shareholders. Based on this
prediction, it is expected family control through family ownership concentration reduces the monitoring
effectiveness of independent boards. The following hypothesis is developed to test this expectation:
Hypothesis 2: Independent boards of directors are less effective to monitor EM in family-owned firms compared to
4.2.2 Audit Committees and EM in Family-owned Firms
In the last few decades, the importance and role of audit committees in the quality of financial reporting have
received substantial attention from academics and regulators, and there have been corporate governance
pronouncements, such as the Cadbury Committee (1992) in the UK and the Blue Ribbon Committee (1999) in the
U.S.
In the corporate governance mechanism, the audit committee represents the board and enables personal contact and
communication between the board, internal auditors, external auditors, the finance director and the operating
executives (Song & Windram, 2004). The essential role of the audit committee is to monitor financial reporting, and
it behaves as a final protection in approving the financial statements prior to their release to shareholders and other
stakeholders. Therefore, an independent audit committee is expected to reduce the opportunistic and self-interested
manipulation of financial information by managers, and previous studies have provided evidence for this prediction
(Baxter & Cotter, 2009; Chang & Sun, 2010; Xie et al., 2003).
Because the audit committee is a sub-committee of the corporate board, the same agency issues specific to the boards
of family-owned firms are also a problem for their audit committees. The owning-familys pursuit of its own
interests and altruistic behaviors may affect the regular assembly of the audit committee, and this may prevent the
efficient detection of managerial opportunism by the committee. Based on this prediction, it is expected family
control through family ownership concentration reduces the monitoring effectiveness of independent audit
committees. The following hypothesis is developed to test this expectation:
Hypothesis 3: Independent audit committees are less effective to monitor EM in family-owned firms compared to
4.2.3 Internal Audit Function and EM in Family-owned Firms
The important monitoring role of the Internal Audit Function (IAF) has received much attention from academics and
regulators as an important contributor to effective corporate governance. Agency theory provides a framework to
express the demand for internal auditing and recommends a monitoring role for the internal audit.
The IAF is the only party which is responsible for the day-to-day implementation, testing, and monitoring of the
actions of management, and so has the potential to affect a companys external financial reporting (Prawitt et al.,
2009). Although the IAF may be effective in reducing EM practices, this relationship has not been extensively
examined in the literature. One prior effort which uses archival data to examine the effect of IAFs on EM found no
evidence that the presence of an IAF is associated with a lower level of EM (Davidson et al., 2005). Expanding on
the scope of the Davidson's study, Prawitt et al., (2009) has found evidence that high IAF quality moderates the level
of EM. However, empirical research investigating the monitoring ability of an IAF on the opportunistic behaviors of
managers in family businesses is limited.
Acknowledging that the internal audit department reports to the audit committee, which is a sub-committee of the
board, and that, in most family-owned firms, owning-families generally, prefer to establish cooperative boards. As a
result of weak monitoring by internal audit functions of family-owned firms, presence of IAF is not related with the
level of EM in family-owned firms. The following hypothesis is developed to test this expectation:
Hypothesis 4: The presence of an IAF is negatively related to the level of EM in non-family-owned firms, but is
unrelated to the level of EM in family-owned firms.
5. Sample Selection
The empirical analysis was carried out using a Turkish data set. Under Turkish Disclosure rules, publicly-held joint
stock companies have been required to declare the Corporate Governance Compliance Reports in their annual
reports since 2004. Content analyses of the yearly annual reports of all non-financial firms listed in the ISE were
carried out for each of the five reporting period between 2006 and 2010. Unfortunately, not all companies disclosed
the full set of corporate governance data needed for the empirical analysis. After excluding the companies that didn't
provide the necessary information for the analysis, the sample consisted of 93 firms. The sample was then divided
according to industry due to the method used in measuring EM; for the calculations, each industry had to include at
least 8 firms. After the elimination of firms belonging to industries which did not support the minimum number
requirement, the final sample consists of eighty-two firms (seventy-four manufacturing and eight technology) and
410 firm-year observations. Table 1 illustrates the derivation of the sample.
Table 1. Derivation of Sample
Description Sample Size
Total Numbers of Firms Listed In ISE Between The Years 2005 To 2010:
Less: Financial Institutions:
Less: The Number of Firms Which All of the Annual Reports Between Years 2005 to 2010
Has Not Been Found.
Less: The Firms Which Has No Required Corporate Governance Data in the Compliance
Reports.
Less: The Firms which belongs the industry which does not have the required numbers of
firms.
Firms Available for Final Sample
262
74
56

39
11

82

Once the sample was selected, the family-owned firms were distinguished from the non-family ones. In this study,
the ultimate shareholders of the firms were determined by analyzing the pyramidal ownership structures, and firms
were assumed to be family-owned when a family was the biggest shareholder. Information demonstrating these
pyramidal structures was obtained from Turkeys Public Disclosure Platform (kap.gov.tr). By this methodology, of
the eighty-two firms in the sample, thirty-six were determined to be family-owned firms.
6. Results
6.1 Discretionary Accruals
In the present study, discretionary accruals are estimated from the performance-adjusted cross-sectional variation of
the modified Johns model (Kothari et al., 2005). For each year and for each industry group, total accruals are
modeled as a function of change in revenues adjusted for the change in receivables, the level of plant, property and
equipment, and Return on Asset using the following cross-sectional OLS regression model.
TA
it
/ A
it-1
= 0 + i [1/A
it-1
] +
1i
[(REV
it
- AR
it
) / A
it-1
] +
2i
[ PPE
it
/ A
it-1
] +
3i
ROA
it(or it-1)
+
it

where;
TA
it
= total accruals in year t for firm i;
REV
it
= revenues in year t less revenues in year t-1 for firm i;
REC
t
= net receivables in year t less net receivables in year t-1;
PPE
it
= gross property, plant, and equipment in year t for firm i;
ROA
it
= return on asset in year t for firm i;
A
it-1
= total assets in year t-1 for firm i;
it
= error term in year t for firm i;
i= firm index;
t= year index for the years included in the estimation period for firm i.
The model is applied to the two industry groups of seventy-four manufacturing and eight technology firms separately
for each year from 2006 to 2010. This model estimates parameters for predictive purposes rather than testing the
statistical significance of parameters. The coefficients obtained from the above equation are used to determine
firm-specific non-discretionary accruals, and discretionary accruals are obtained as the difference of total accruals
and non-discretionary accruals.
Unlike Dechow, Sloan, and Sweeney (1995), the current study assumes that changes in accounts receivable are
unmanaged and that observable changes arise from EM (Kothari et al., 2005). Dechow et al. (1995) assume that sales
are not managed in the pre-event period, and the change in accounts receivable in the event year is due to EM.
Because the current study does not have a pre-event period, the equation in which the parameters are determined is
also modified for the effects of changing levels of accounts receivable (Kothari et al., 2005). In the study, the cash
flow approach is used to determine total accruals (Davidson et al., 2005; Klein, 2002; Larcker et al., 2007; Prawitt et
al., 2009) as the difference between the net income before extraordinary items and cash flow from operations, which
is obtained from the statement of cash flows.
The following models are designed to examine the relationship between the absolute and directional values of
discretionary accruals, as well as whether a firm is family-owned or non-family-owned, after controlling for the
effects of other variables discussed in the literature for their relevance to EM.
ABSAbbAcc
it
=
0
+

1
PFamilyFirm+
2
Assets
it
+
3
Leverage
it
+
4
SGrowth
it
+
5
ROA
it
+
6
Loss + (1)
AbbAcc
it
=
0
+

1
PFamilyFirm+
2
Assets
it
+
3
Leverage
it
+
4
SGrowth
it
+
5
ROA
it
+
6
Loss + (2)
In the first model, the dependent variable is ABSAbbAcc, which is the absolute value of performance adjusted
discretionary accruals. In the second model, the dependent variable is AbbAcc, which shows the negative and
positive abnormal accruals.
The independent variable is PFamilyFirm, which is the predicted value of family ownership. Following prior studies
which suggest that concentrated ownership by families and performance of firm may be endogenously determined
(Jaggi et al., 2009; Anderson & Reeb, 2003), first family ownership is regressed with the natural log of total assets
and ROA (return on asset) to obtain the predicted value of family ownership. Other variables are defined as follows:
Assets is the natural log of total assets. There are two opposite views about the sign of this variable. The first
suggests that big firms with a high chance of receiving political attention are more likely to manipulate earnings to
avoid political scrutiny (Jeong & Rho, 2004), and some studies evidence that asset size correlates positively with
abnormal accruals (Dechow & Dichev, 2002; Chtourou & Bedard, 2001; Prawitt et al., 2009). The second view
suggests that larger firms are more visible so are less likely to manage earnings (Chen, Lin, & Zhou, 2005), and other
studies findings support this prediction (Davidson et al., 2005; Wang, 2006). Another control variable, Leverage, is
measured as total debt divided by total assets. DeFond and Jiambalvo (1994) and Iatridis and Kadorinis (2009)
provide evidence that managers manipulate earnings to avoid getting close to debt covenants, and this variable is
widely used in EM studies (Peasnell et al., 1998; Klein, 2002; Park & Shin, 2004; Davidson et al., 2005; Chen et al.,
2005; Carcello et al., 2006; Prawitt et al., 2009; Baxter et al., 2009; Chang & Sun, 2010). Matsumoto (2002) claims
that managers of high-growth firms have major incentives to avoid missing earnings expectations, creating an extra
incentive for them to manage earnings. Consistent with Prawitt et al. (2009), this study controls for the effects of
sales growth on EM. SGrowth measures the one-year sales growth of firms. ROA is included to control for potential
changes in firm performance. This is because prior research provides evidence that measurement of discretionary
accruals can be a problem for firms which have extreme financial performance (Dechow et al., 1995; Kothari et al.,
2005). Following prior studies, Loss is also added as a control variable to clarify managers incentive to avoid losses
(Chen et al., 2005; Prawitt et al., 2009; Baxter, 2009). Burgstahler and Dichev (1997) state that firms manage reported
earnings to avoid reporting earnings decreases and losses.

Table 2. Discreationary Accruals and Family-owned Firms
Regression Estimates
Dependant Variable= ABSAbbAcc Dependant Variable= AbbAcc

Expected
sign Coefficient t-stat
Expected
sign Coefficient t-stat
Intercept -0.1733 -1.49 0.1502 1.34
PFamilyFirm -0.3180 -3.05** 0.0362 0.35
Assets 0.0196 2.47** -0.0085 -1.16
Leverage 0.0478 4.59*** -0.0182 -1.15
SGrowth 0.0002 0.92 0.0003 1.18
ROA -0.1036 -1.21 0.2711 3.94***
Loss 0.0077 0.43 -0.0129 -0.72
R-square (between) 0.2037 0.4161
Prob>Chi
2
0.0001 0.0000
Number of observations 410 410
The reported t-statistics are robust values to control for heteroskedasticity.
ABSAbbAcc= Absolute value of discreationary accruals
AbbAcc= Directional values of discreationary accruals
PFamilyFirm= Predicted value of regressing family ownership on the natural log of total assets and
ROA.
Assets= The natural log of total assets
Leverage= Total debt divided by total assets
Sgrowth= One year sales growth
ROA= Return on Asset
Loss= Dummy variable takes the value of 1 if net income is less than zero firm i in year t, 0 otherwise.
*, ** , *** Denote Significance at the 0.1, 0.05 and 0.001 level respectively.
Table 2 reports the regression estimates of the equations. The coefficient on PFamilyFirm is significant for
ABSAbbAcc model (-0.3180, t=-3.05). This result is consistent with previous studies of Italy (Prencipe and Bar-Yosef,
2011) and the US (Jiraporn and Dadalt, 2007; Wang, 2006) which find that the absolute value of abnormal accruals is
lower for family firms. However, this study finds no significant difference between the sign of the discretionary
accruals of family-owned firms and non-family-owned firms. The coefficient on PFamilyFirm is insignificant for the
AbbAcc model (0.0362, t=0.35). In the case of directional abnormal accruals, the findings are not consistent with the
US-based study by Ali et al. (2007), which shows that discretionary accruals are more negative for family firms than
for non-family firms. Overall, the results suggest that, in Turkish family-owned firms, total accrual management is
lower in family-owned firms compared to non-family-owned firms, but that, in family-owned firms,
income-decreasing accruals resulting from Type II agency conflict do not dominate income-increasing accruals
resulting from Type I agency conflict.
6.2 Corporate Governance and EM in Family-owned Firms
6.2.1 Descriptive Statistics
Table 3 presents descriptive statistics of the data. First, although it was stated previously that the large majority of listed
companies in ISE are family-owned firms, note that just 44 percent of the full sample is composed of family-owned
firms. Because the sample includes only firms with full disclosure of corporate governance data, most family-owned
firms were eliminated because such data was unavailable. Ali et al. (2007) provide evidence that family firms tend to
report less information about their corporate governance practices.

Table 3. Descriptive Statistics
Panel A: Descriptive Statistics of Full Sample Panel B: Comparison of Statistics of Two Sub samples
Full Sample Mean Std. Dev.
Mean Std.
Dev.
Min. Max. Family-
Owned
firms
Non-Family-
Owned firms
t-stat Family-
Owned
firms
Non-Family-
owned firms
BoardInd 0.80 0.39 0 1 0.78 0.81 0.60 0.41 0.39
ACInd 0.85 0.35 0 1 0.83 0.86 1.02 0.37 0.33
IAF 0.46 0.49 0 1 0.52 0.42 -2.01** 0.50 0.49
BoardMeet 22.3 12 2 93 22.13 22.58 0.37 10.87 12.87
ACSize 2.16 0.45 1 4 2.15 2.18 0.71 0.43 0.47
ACTimeCom 0.92 0.25 0 1 0.9 0.95 2.05** 0.30 0.21
Big4 0.52 0.50 0 1 0.64 0.43 -4.18*** 0.48 0.49
ConcOwner 0.63 0.17 0.12 0.99 0.64 0.63 -0.93 0.15 0.19
ForeignInv 0.25 0.43 0 1 0.29 0.23 -1.24 0.45 0.42
Assets 19.41 1.40 15.88 22.71 19.69 19.18 -3.69*** 1.49 1.29
Leverage 0.47 0.46 0.02 4.13 0.52 0.44 -1.59 0.57 0.35
Sgrowth 17.53 107.50 -99.62 1593.2 22.68 13.50 -0.85 141.46 70.43
ROA 0.029 0.196 -2.88 1.005 0.026 0.031 0.24 0.14 0.22
Loss 0.26 0.44 0 1 0.283 0.25 -0.70 0.45 0.43
Panel C: Proportions of Variables within Sub samples
Family-owned firms Non-Family-Owned firms
BoardInd Comprised of majority of non-executive directors 0.79 0.81
Comprised of majority of executive directors 0.21 0.19
ACInd Comprised of majority of non-executive directors 0.83 0.87
Comprised of majority of executive directors 0.17 0.13
IAF Have an IAF 0.52 0.42
Do not have an IAF 0.48 0.58
AC TimeCom Serve in more than one committee 0.10 0.05
Do not serve in more than one committee 0.90 0.95
Big4 Audited by a Big4 0.64 0.43
Audited by an Auditing Firm other than Big4 0.36 0.57
Loss

Experienced a Loss 0.28 0.25
Do not experienced a loss 0.72 0.75
ForeignInv Owned by an institutional foreign investor 0.29 0.23
Do not owned by an institutional foreign investor 0.71 0.77
Panel B of table 3 reports the comparison of statistics of family-owned and non-family-owned sub-samples. The
variables IAF, Big4, and Assets are significantly higher for family-owned firms. For all other variables, there is no
significant difference between family-owned and non-family-owned firms.
6.2.2 Regression Results
The following model is estimated to examine the effect of board independence, audit committee independence, and
the presence of an internal audit function on the level of discretionary accruals.
ABSAbbAcc
it
=
0
+

1
BoardInd
it
+
2
ACInd
it
+
3
IAF
it
+
4
BoardMeet
it
+
5
ACTimeCom +
6
ACSize
it
+
7

Big4+
8
Assets
it
+
9
Leverage
it
+
10
SGrowth
it
+
11
ROA
it
+
12
Loss+
13
ConcOwner +
14
ForeignInv +
(Model 1) (3)
In model 1, the dependent variable is ABSAbbAcc, which is the absolute value of performance-adjusted discretionary
accruals. The absolute value of discretionary accruals is used rather than directional values because the study has
previously found no difference between the directions of discretionary accruals of family- and non-family-owned
firms. The first independent variable is BoardInd, a dummy variable which takes the value 1 if the firms board of
directors is comprised of a majority of non-executives, otherwise 0. Following prior research (Davidson et al., 2005;
Baxter & Cotter, 2009) and the recommendation of the Capital Market Board of Turkey (CMB), the present study
measures the independence of the board of directors by whether the majority of directors are non-executives. The
second independent variable is ACInd, which takes the value 1 if the committee is comprised of a majority of
non-executive directors, otherwise 0. The Corporate Governance Principles of Turkeys CMB require that each
committee should comprise at least two members and, if there are only two members, both of them should be
non-executive members. If there are more than two members in a committee, the majority of members should be
non-executive members. The third independent variable of the model is IAF, which takes the value 1 if the company
has a separate IAF, otherwise 0.
Following prior research, some control variables related to the governance structures of firms have been added to the
model. BoardMeet is the number of board meetings held annually by the board of directors. Prior studies assume that
if a board meets more often it should have more time to discuss special issues and be more capable of controlling
managers discretionary behaviors (Carcello et al., 2006; Xie et al., 2003; Baxter et al., 2009). CMB principles
require that the members of the board of directors cannot be assigned to more than two committees. To control for
this requirement, the current study measures the multiple time commitments of audit committee members
(ACTimeCom) by whether committee members serve on more than one committee. ACSize is another control
variable. The CMB recommends that the board should establish an audit committee with at least two members.
Following prior research (Davidson et al., 2005; Baxter et al., 2009; Felo, Krishnamurthy, & Solieri, 2003; Xie et al.,
2003), the current study measures audit committee size simply by the numbers of audit committee members. Again
following prior studies (Chtourou & Bedard, 2001; Jeong & Rho, 2004; Davidson et al., 2005; Chen et al., 2005;
Carcello et al., 2006; Piot & Janin, 2007; Baxter & Cotter, 2009; Chang & Sun, 2010), the current study uses Big4 as
a control variable which takes the value of 1 if the firm is audited by one of the big four auditing firms, otherwise 0.
The study controls for the effects of large block holders and measures ConcOwner as the percentage of shares held
by the largest three substantial shareholders with more than 5 percent of the shares. Jensen (1993) states that large
block shareholders have incentives to monitor management and serve as an additional control mechanism. This study
also controls for the effects of foreign institutional investors by assuming that they are a control mechanism reducing
discretionary behaviors by the managers. Their presence is measured by the variable ForeignInv, which takes the
value of 1 if company has institutional foreign investor, 0 otherwise.
Table 4. Pearson (Top) and Spearman (Bottom) Correlations Coefficients among the Variables

Table 4 illustrates the correlation coefficients between the variables. Pair-wise correlation between two variables
lower than 0.80 is not assumed to be a problem that threatens the regression analysis (Gujarati, 2004). Relatively
high correlation between two independent variables (60 percent between the BoardInd and ACInd) and two control
variables (78 percent between ROA and Loss) is ignored and they are used in the same model to avoid the correlated
omitted variable bias associated with a combination of variables.
The study provides separate regression tests on the full- and sub-samples of family-owned and non-family-owned
firms for model 1. This is because it has been suggested that regression tests made seperately on two groups may
give better results when the relationship between the independent and dependent variables is hypothesized to be
contingent on the moderator variablein this case, family ownership (Staw and Oldham, 1978; Wright, Ferris, Sarin,
& Awasthi, 1996).
Table 5. Regression Results of Model 1 and Model 2
Panel A: Regression Results of Model 1 Panel B: Regression
results of Model 2
Full Sample Family Owned Not Family Owned
Expected Coefficient t-stat Coefficient t-stat Coefficient t-stat Coefficient t-stat
PFamilyFirm -0.5463 -4.16***
BoardInd - -0.0428 -2.69*** -.0.1435 -0.59 -0.0316 -2.07** -0.2531 -3.03***
ACInd - 0.0105 0.41 -0.0449 -0.70 0.0288 1.67* 0.0279 0.33
IAF - -0.0192 -2.04*** -0.0343 -1.37 -0.0175 -2.10** 0.0308 0.82
PFamilyFirm* 0.5162 2.55**
PFamilyFirm* -0.0569 -0.28
PFamilyFirm* -0.1249 -1.39
Board Meet - -0.0005 -1.77* -0.0010 -1.88* -0.0007 -1.75* -0.0002 -0.92
AC Size - 0.0028 0.32 0.0085 0.58 0.0004 0.04 0.0009 0.11
AC TimeCom - 0.0169 1.07 0.0323 1.08 0.01103 0.61 0.0195 1.20
Big4 - 0.0136 1.27 0.0315 1.55 -0.0001 -0.01 0.0116 0.277
ConcOwner - -0.0487 -1.20 0.0293 0.28 -0.0937 -2.99*** -0.0391 -0.90
ForeignInv - 0.0084 -0.64 -0.0260 -1.07 0.0084 0.62 0.0021 0.16
Assets ? 0.0022 0.66 0.0040 0.76 0.0076 1.86 0.0177 2.53**
Leverage + 0.0160 2.01** 0.0188 0.92 0.0005 0.03 0.0438 3.10***
Sgrowth + 0.0002 0.88 0.0002 0.82 0.0000 1.17 0.0002 0.89
ROA - -0.1108 -1.02 0.2220 2.74*** -0.2137 -3.74*** -0.0852 -1.16
Loss + -0.0077 -0.35 0.0643 2.78*** -0.0030 -1.93** 0.0082 0.50
Prob>Chi
2
0.0000 0.0000 0.0000 0.0000
R
2
(between) 0.3536 0.3497 0.4071 0.3660
The reported t-statistics are robust values to control for heteroskedasticity. *, ** , *** Denote Significance at the 0.1, 0.05 and 0.001
level respectively.
PFamilyFirm= Predicted value of regressing family ownership on the natural log of total assets and ROA.
BoardInd= Dummy variable takes the value of 1 if Board of Directors is comprised of a majority of non-executives, otherwise 0
ACInd =Dummy variable which takes the value of 1 if the committee is comprised of a majority of non executive directors, otherwise
0.
IAF=Dummy variable takes the value of 1 if the company has a separate internal audit function, otherwise 0.
PFamilyFirm* BoardInd= Interaction term between PfamilyFirm and BoardInd variables.
PFamilyFirm* ACInd= Interaction term between PfamilyFirm and ACInd variables
PFamilyFirm* IAF= Interaction term between PfamilyFirm and IAF variables
BoardMeet= The number of board meetings held annually by the board of directors
AC Size= Number of directors assigned to the Committee
AC TimeCom= A dummy variable which takes the value of 0 if at least one committee member serve in another committee for firm i
in year t, otherwise 1.
Big4= A dummy variable which takes the value of 1 if the firm i is audited by one of the Big 4 Auditing Firm in year t, otherwise 0.
ConcOwner= Percentage of shares held by the largest three substantial shareholders.
ForeignInv= Dummy variable takes the value of 1 if company has institutional foreign investor, 0 otherwise.
Assets= The natural log of total assets
Leverage= Total debt divided by total assets Sgrowth= One year sales growth
ROA= Return on Asset Loss= Dummy variable takes the value of 1 if net income is less than zero firm i in year t, 0 otherwise.

The regression results of model 1 are reported in panel A of table 5. The results based on the full sample indicate that
the coefficient for BoardInd is statistically significant and negative (-0.0428 t=-2.69), suggesting that firms which
have independent boards are associated with lower discretionary accruals. This finding is consistent with the findings
of Jaggi et al. (2009), Chtourou et al., (2001), Davidson et al., (2005), and Peasnell et al., (2005). The coefficient for
BoardInd is also negative but insignificant (-0.014 t=-0.59) in the sub-sample of family-owned firms and negative
and significant (-0.0316 t=-2.07) for the sub-sample of non-family-owned firms. These results are consistent with the
findings of Jaggi et al. (2009) and Prencipe & Bar-Yosef (2011). These findings validate hypothesis 2 that
independent boards of directors are less effective at monitoring EM in family-owned firms compared to in
non-family-owned firms. Consequently, although board members are formally independent in family-owned firms,
they may be not independent in substance because of implicit ties to the controlling family.
Hypothesis 3 would be validated if the coefficient of ACInd was significant and negative for non-family-owned firms
and insignificant or positive for family-owned firms. Inconsistent with the expectations, it is positive and
insignificant for the full sample (0.0105 t=0.41). This is consistent with the findings of Chotorou et al. (2001), but
inconsistent with the findings of Xie et al. (2003) and Chang and Sun (2010), who find a significant negative
relationship. The coefficient of ACInd is negative and insignificant for sub-sample of family-owned firms (-.0.449
t=-0.70) and positive and significant for non-family-owned firms (0.0288 t=1.67). These findings do not support
hypothesis 3 that independent audit committees are less effective at monitoring EM in family-owned firms compared
to in non-family-owned firms. These findings are inconsistent with those of Jaggi and Leung (2007) which suggest
that the presence of audit committees is effective in constraining managerial EM behavior when no family members
are present on corporate board.
As expected, the coefficient of IAF is negative and significant (-0.0192 t=-2.04) for the full sample. This suggests
that the presence of a separate internal audit function is effective in reducing EM made through accruals in Turkish
firms. The findings of regressions on sub-samples validate hypothesis 4 that the presence of an IAF is negatively
related to the level of EM in non-family-owned firms, but is unrelated to the level of EM in family-owned firms. The
coefficient of IAF is negative and insignificant for family-owned firms (-0.0343 t=-1.37) and negative and significant
for non-family-owned firms (-0.0175 t=-2.10).
The results for the control variables show that the coefficient of BoardMeet is significant and negative for all
samples. However, contrary to expectations, the coefficient is higher for family-owned firms (-0.0010 t=-1.88)
compared to non-family-owned firms (-0.0007 t=-1.75), suggesting that regular meetings of the board are more
effective at reducing EM in family-owned firms. The coefficient of ConcOwner is only negative and significant
(-0.0937 t=-2.99) for non-family-owned firms. One possible explanation for this finding may be that the concentrated
owners of family-owned firms are family members, and a conflict may occur between their self-interest and the
motives of concentrated ownership in monitoring the behavior of managers. On the other hand, in non-family-owned
firms, concentrated owners are more motivated than minority shareholders to control managerial behavior. The
coefficient of Big4 is insignificant for all samples, and this is inconsistent with the findings of Karacaer and zek
(2010), who find a significant negative relationship between external auditor size and the level of abnormal accruals
in Turkish firms.
The effects of ROA and Loss on EM are mixed for family-owned firms and non-family-owned firms alike.
Unexpectedly, the coefficient of ROA is positive and significant for family-owned firms (0.2220 t=2.74) but is, as
expected, negative and significant for non-family-owned firms (-0.2137 t=-3.74). Loss is positive and significant for
family-owned firms (0.0643 t= 2.78) as expected, but negative and significant for non-family-owned firms (-0.0030
t=-1.93). The coefficient of Assets is positive and insignificant for all samples. Although it is insignificant, the
positive sign implies that big firms with a high chance of receiving political attention are more likely to manipulate
accounting numbers to avoid political scrutiny, consistent with the findings of Dechow and Dichev (2002), Chtourou
and Bedard (2001), and Prawitt et al. (2009).
Additionally, the impact of family ownership control on the association between abnormal accruals and independent
variables was examined by including interaction variables between PFamilyFirm and independent variables.
ABSAbbAcc
it
=
0
+

1
PFamilyFirm
it
+
2
BoardInd
it
+
3
ACInd
it
+
4
IAF
it
+
5
PFamilyFirm
it
* BoardInd
it
+
6
PFamilyFirm
it
* ACInd
it
+
7
PFamilyFirm
it
* IAF
it
+
8
BoardMeet
it
+
9
ACTimeCom
it
+
10
ACSize
it
+
11
Big4
it
+
12
Assets
it
+
13
Leverage
it
+
14
SGrowth
it
+
15
ROA
it
+
16
Loss
it
+
17
ConcOwner
it
+
18
ForeignInv
it
+ (Model 2) (4)
The results of model 2 are reported in panel B of table 5. The coefficient of BoardInd is significantly negative
(-0.2531, t=-3.03) and the interaction term on PFamilyFirm* BoardInd is positive and statistically significant (0.5162,
t=2.55). These results are consistent with hypothesis 2, showing that family-ownership control moderates the
monitoring effectiveness of independent boards. The coefficient of IAF and interaction term between FamilyFirm
and IAF are both insignificant and do not validate hypothesis.
7. Conclusions and Limitations
This paper has evaluated the moderating effect of family ownership on the relationship between the independent
variables of board independence, audit committee independence and presence of internal audit function and the
dependent variable of abnormal accruals. Overall, the findings provide evidence that family ownership in listed
Turkish firms moderates the monitoring effectiveness of independent boards, proxied by a majority of non-executive
directors on the board, and the monitoring effectiveness of an internal audit function.
This research has some limitations which should be considered when interpreting its research findings. Firstly, there
is its sample selection bias; the selection of the study sample was based on a predetermined criterion, and so was
non-random. However, because there are only a limited number of firms that disclose comprehensive and relevant
corporate governance information publicly, it is very difficult for corporate governance studies in Turkey to select
firms randomly. Consequently, the limited sample size is another concern.
Another potential limitation may arise from the measurement of EM practices through the magnitude of abnormal
accruals. Because accrual models make some assumptions when calculating the discretionary part of the total
accruals, this may also affect the interpretation of the results.
Nevertheless, the results of this study may be used by stock market participants when evaluating the roles of internal
corporate governance mechanisms in increasing the quality of reported earnings. The findings will also help
regulators to define effective corporate governance attributes according to different institutional environments and to
assess the requirements for disclosure of corporate governance practices.
To extend the current literature, further investigation of the quality of internal audit functions in family firms and the
presence of real EM in family firms may be beneficial.
Acknowledgements
This paper is a significantly revised version of authors dissertation at the Business School of Marmara University,
Turkey. Author thanks her dissertation committee. The author has also benefited from comments and discussions
with Prof. Agnes Cheng from Louisiana State University, Yasemin zerkek from Marmara University, Hseyin
Kaya and Blent Anl from Baheehir University, conference participants at the EBES Conference (Rome).
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Notes
Note 1. Although, as in many emerging markets, the number and size of the joint stock companies have continued to
increase, Turkey has an underdeveloped equity culture. Market capitalization of Turkey as a percentage of GDP was
around 16 percent, 38 percent and 40 percent for the years 2008, 2009 and 2010 respectively (Bulletin of the Capital
Markets Board of Turkey, 2010), significantly below the OECD averages of 60 percent, 83 percent, and 90 percent
for those years respectively
(http://www.indexmundi.com/facts/oecd-members/market-capitalization-of-listed-companies, 2011) .
Note 2. During the period under analysis, the old Turkish commercial law was in force. The new commercial law
became effective on 1 July, 2012, and also permits issuing non-voting shares and shares which have an arbitrarily
high number of votes.

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